Know About the New IRS Rules for Reporting Foreign Financial Assets?

International tax evasion: In this time of economic crisis for many countries around the world, anti-fraud measures at the individual and corporate level are a major focus for governments and their taxing and regulatory authorities.

Recently, the U.S. government has launched major initiatives to disclose unreported income from foreign assets, which has been estimated to cost the federal Treasury between $40 billion and $70 billion in individual income taxes alone.

If you have a financial interest in, or signature authority over, a foreign bank or other financial account, you may already be filing Form TD F 90-22.1 Report of Foreign Bank and Financial Accounts — commonly referred to as FBAR. The FBAR filing deadline is in June. (For more information on the FBAR reporting requirement, check out our previous post, Subject to FBAR Reporting? Final Regulations Change the Rules for June 2011 Filings.)

Now, under new and different rules (issued as temporary regulations by the IRS on December 16, 2011) you may also be required to report certain of your foreign financial assets on a new Form 8938 as part of your federal income tax return. Although the regulations were issued last month, the new rules apply to the 2011 tax year and the penalties for failing to file Form 8938 can be quite substantial.

If you owned specified foreign financial assets during 2011 and the aggregate value exceeded certain minimum threshold amounts, this new reporting requirement applies to your 2011 tax return. It does not, however, replace the existing FBAR filing requirement. Depending on the circumstances, you may be required to file both forms.

Who Must Report Foreign Financial Assets on Form 8938?If you are a person with an interest in reportable foreign financial assets—and you are a U.S. citizen, a resident alien, or a certain type of nonresident alien—you are potentially subject to the new regulations. That said, if you’re not required to file an income tax return for the year, you’re not required to file Form 8938.

Currently, domestic entities are not required to file Form 8938. However, under proposed regulations certain domestic entities formed to hold financial assets may be subject to the filing requirements for tax years beginning after December 31, 2011.

What Are the Reporting Thresholds?To reduce the filing burden on individuals with small foreign holdings, the regulations establish minimum thresholds below which you aren’t required to file Form 8938. These minimum thresholds are as follows:

If you are living in the U.S. and file your federal income tax return as either single or married filing separately, the total value of your foreign financial assets must exceed $50,000 on the last day of the tax year or have exceeded $75,000 at any time during the tax year. If you’re married and file a joint tax return, the threshold amounts are $100,000 and $150,000, respectively.

The thresholds are somewhat higher if you’re living abroad, although to qualify you must either be a U.S. citizen with a tax home in a foreign country or a U.S. citizen who was physically outside of the U.S. for at least 330 days during the tax year. Under these circumstances, your foreign financial assets must exceed $200,000 on the last day of the tax year or have exceeded $300,000 at any time during the tax year—$400,000 and $600,000 if you’re married and filing a joint return.

Which Foreign Financial Assets Must Be Reported?The new tax rules for reporting foreign assets on Form 8938 apply only to specified foreign financial assets. These assets generally include the following:

foreign accounts maintained by a foreign financial institution

other foreign financial assets that are not in accounts maintained by a foreign financial institution: stock or securities that aren’t issued by a U.S. person, an interest in a foreign entity, and a foreign contract or other financial instrument with an issuer or counterparty that is not a U.S. person

an interest in a foreign estate or trust, assuming you know or have reason to know of your interest based on readily available information or a past distribution

You do not have to report foreign accounts maintained by a U.S. financial institution or other domestic payer, the U.S. branch of a foreign financial institution, or the foreign branch of a U.S. financial institution.

For those assets that are reportable on Form 8938, it’s important to recognize that you’ll need to provide more detailed information than is required for FBAR reporting purposes—including such things as the names of stocks and the amounts of foreign currencies. You’ll also need to indicate where the income from these assets is reported on the tax return.

Potential Penalties If you to fail to file Form 8938 as required, you’re subject to a penalty of $10,000. If you still haven’t filed after receiving a notification from the IRS, the penalty increases up to a maximum of $50,000.

You may also be subject to an underpayment penalty equal to 40 percent of any underpaid tax and an extended statute of limitations.

If you have questions about these new filing requirements or believe you may be required to file Form 8938 this year, give us a call. Because the tax rules and forms are new and complex, and because key definitions and reporting requirements differ for Form 8938 and FBAR purposes, it’s critically important to deliver the information necessary to prepare your taxes early this year.

About Scott F. Usher

Scott Usher is a principal in the Bader Martin's tax practice. He is also a leader in the firm's startup / technology and international practice groups.